Value investing in a post pandemic world
Dividend-paying stocks can provide a relatively stable way of accessing the growth potential of the stock market. Join Clare Hart, Andrew Brandon, and David Silberman, Portfolio Managers, U.S. Equity Group, for a discussion on lessons learned from 2020 and opportunities they are seeing in value investing in 2021.
What is your investment philosophy? What do you look for in the companies you buy?
We consistently look to invest in quality companies at reasonable valuations. For some of our clients, we also have an income or yield mandate that we pursue by buying dividend-paying companies.
What happened in 2020, and what lessons did you learn?
Some people look at 2020 and compare it to the global financial crisis. There are similarities, of course. In both cases, markets were in extreme distress. But the differences are more pronounced. First, unlike the financial crisis, in 2020 there was a lot of capital around globally. Second, while the financial crisis unfolded over about a year, the coronavirus crisis was much more truncated. We took advantage of an attractive opportunity set, but then, given the speed of the recovery, it effectively disappeared. We always look to invest in quality companies, and this helped us identify who was positioned to survive the short term and go on to thrive in a post-pandemic environment.
How do ESG considerations factor into your thinking?
First, we should note that environmental, social, governance (ESG) considerations have become an integral part of the investment process across our global equity platform. We have a 40-question ESG questionnaire for each company under coverage by the U.S. Equity team. We consider the key ESG issues that could be impacting a company.
As investors, we look to buy good businesses with strong management teams and governance. The approach we take as a team tends to lead us to companies that have very strong ESG scores. Our approach is not exclusionary, though. That means we can own companies that score poorly on some ESG metrics. We can engage with companies and be part of the dialogue to address the ESG issues they face. In conjunction with our stewardship teams globally, we generally get a seat at the table. Incorporating ESG into our analysis helps us better understand the risks and opportunities for the companies that we cover.
Last year was really an acid test for business models and for management team savvy.
Where do you see opportunities?
Over the past year, we’ve focused on the consumer. For us, the consumer sector has been—and continues to be—a great opportunity set. We’ve asked ourselves, Where are consumers spending their money in the pandemic? Where will they continue to spend their money when the pandemic is over? How could that change?
We think about retail in particular. Of course we’re looking for retailers that can navigate the threat of Amazon, a formidable competitor. But more than that, they need to deliver to the consumer in the way the consumer wants to be served. During the pandemic, people needed to shop from home, which meant that companies had to have already invested in the infrastructure to make that happen. Last year was really an acid test for business models and for management team savvy. Some retailers that we would not have considered in the past actually navigated the crisis quite well. As a result, we’ve added some new retailers to the platform.
Industrials proved to be an area of great opportunity last year. In 2Q20, when it felt like things were falling off a cliff, we had a lot of confidence in the large multi-industrial companies we own, companies with good balance sheets, diverse end markets and strong management teams. We didn’t know how long or deep the downturn would be, but we had confidence that these companies would make it through. And they did. We added to existing holdings and bought some new positions. Today, however, as investors are pricing in a more optimistic outlook, higher valuations make the sector a little less exciting.
The energy sector, by contrast, looks more interesting. Historically, these companies have taken just about every dollar they generated and put it back into the ground. But management teams are now much more disciplined. We started buying energy names in the fourth quarter, given the sector had lagged, while oil prices quickly bounced back to USD 40. On a risk-reward basis, they looked much more attractive. We continue to focus on companies with high quality, well-located assets, sturdy balance sheets and a shareholder-friendly approach to capital allocation.
Turning to technology, we favor semiconductors, and our primary exposure has been in the analog space. We own stocks like Texas Instruments, Analog Devices and NXP—companies with growing total addressable markets, large and highly fragmented end markets that generate strong free cash flows. Analog product cycles tend to be very long, so once a company gets a design win, it tends to hold on to the win for a considerable period of time. Most importantly, perhaps, we see a secular trend toward increased analog content across a wide variety of end markets, including industrial, autos and health care.
What might keep you up at night?
Of course, valuations are quite a bit higher than they were a few years ago. That partly reflects the fact that rates are still quite low. It seems that the Federal Reserve is going to hold out as long as it can before raising rates. If they get it right, that’s great. But if they’re wrong, it could create a lot of market volatility. Additionally, we see some pockets of euphoria, particularly in cryptocurrency and renewable energy. As risks arise, we’ll manage through them, keeping our focus on investing in quality businesses at reasonable valuations—companies we believe are well positioned for the long term.